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Thursday, November 30, 2023

Which Way Wednesday – The Beige Book Boogie

The last Beige Book report was on September 9th.

At the time the Dow was looking toppy at 9,650 and we had poor consumer confidence numbers (just like yesterday) and poor consumer credit number (no change) and the book had very little "good" news to report (see my analysis) – Yet the market broke over 9,600 again that day and then took off all the way to 9,900 a week later.  At the time, we were looking for any excuse to go higher on the hopes that this earnings period will look like last one but have we now come too far, too fast?

It seems we are finally hitting the point of diminishing returns for earnings.  Expectations have finally gotten so high that even big beats aren’t enough to keep the momentum going. 

Last earnings Q, we were down from 8,900 in June to 8,100 on July 9th as companies began reporting and we had a nice, 1,000-point relief rally over the first two weeks of earnings.  This time, we went up an additional 500 points in the past two weeks, over our 9,600 line and that has been in anticipation of a repeat of last earnings but the circumstances are very different this time and it takes a lot to justify a 20% run off the July lows. 

Keep in mind that, looking at the sector charts, Energy, Materials and Tech are leading us.  Since semiconductors are simply another form of commodity – this is almost entirely a commodity rally in the midst of a recession with Consumer Staples, Financials, Health Care, Industrials, Telcom, Utilities and Transports all underperforming the rest of the S&P.  As I keep saying – if no one is shipping anything, how the hell can we be having a proper recovery?

The Beige book is an anecdotal view of the economy gathered roughly through the middle of October and we've seen no improvement in Jobs since the Sept 9th report, Cash for Clunkers ground to a halt and, just this morning, we got a horrific 13.7% decrease in the number of mortgage applications from the previous week.  That number includes "seasonal adjustments," without adjustments, morgage apps plunged 22.4% despite record low rates as government assistance begins to peter out.  The Refinance Index, also adjusted for the holiday, decreased 16.8 percent from the previous week and the seasonally adjusted Purchase Index decreased 7.6 percent from one week earlier.  The unadjusted Purchase Index decreased 16.7 percent compared with the previous week and was 3.4 percent lower than the same week one year ago.

Clearly the earnings reports that are coming in are still doing so mainly on cost cutting, not any underlying improvement in sales.  This week we had GCI with a beat but earnings are down 18%, some other notable revenue numbers are: PETS +5%, WFT -15%, AAPL + 25%, STLD – 54%, TXN -15%, WERN – 26%, EAT – 21%, CAT – 44%, KO – 4%, DRH – 15%, DD – 18%, GAP -5% (that's food!), ITW – 20%, LXK – 15%, EDU +26%, OXPS – 7%, BTU + 24%, PCP – 27%, SHW – 12%, UAUA – 20%, UNH + 8%, WU – 5%, CNI -16%, CREE + 20%, GILD + 31%, ISRG + 19%, NBR – 44%, SNDK + 14%, STX – 12%, STM – 23%, YHOO – 14%, AAI – 11%, APD – 21%, ATI – 50%, CAL – 20%, MAN (jobs) – 26%, SWK – 16%…  

So we get a general impression that sales are off about 15% from last year.  Last year's Q3 wasn't that great you know, the market collapsed in September so we already knew things were falling apart last Q3 so these are not tough revenue comps we are facing.  AFTER getting the revenue and profit numbers last October, the market went down considerably.  Should we be concerned?  Of course we should, any rational person would be but the markets are clearly IRRATIONAL right now so we are playing the market, not the data. 

We have to willingly suspend our disbelief in order to play these markets and our play mix, though still cautious, is reflecting that forced change in attitude.  Sure we still look at the data, but we do so while keeping in mind the great Bill Murray's advice – "It just doesn't matter!"  As fundamentalists, of course we believe it will matter, A LOT, one day, but we're well prepared for that turn.  Meanwhile, let's keep playing the cards we're dealt.

So what if no one is buying houses – they don't have jobs anyway so that's just 13.7% less people who are likely to default on their mortgage.  That must be good for banks right?  Goldman Sach's International Advisor, Brian Griffiths had the same advice as he spoke yesterday defending compensation in the finance industry as his company plans a near-record year for pay, saying the spending will help boost the economy.  “We have to tolerate the inequality as a way to achieve greater prosperity and opportunity for all.”  So don't complain about GS taking record bonuses less than a year after we bailed them out for wrecking the US Economy, they are only making this money FOR YOU! 

This is the same logic under which the entire market is celebrating our drastic reduction in the workforce.  For more than a decade, we've been shifting millions of jobs overseas and it made companies more profitable but there had always been a fear of a backlash against outsourcing if the companies slashed workforces as well.  Our little collapse last year took the stigma out of layoffs and suddenly they were in vogue – everyone is doing it and now the corporations have gotten rid of the "dead weight" of the American workers and now their plans are to focus more on the foreign consumers as these losers in America are all tapped out.  This is just the same sort of slash and burn capitalism that US multi-nationals have practiced globally for decades only now it's the US that's being cut loose as the corporations move on to greener pastures

As good little capitalists, we'll try not to care and we've been focusing our capital on companies that do not need the American consumer to succeed.  Yesterday's trade ideas for Members were a fun mix:  TBT up, ZION bounce, Dow down (rolling puts higher), ISRG flat (wide spread sold), HGSI flat to up, EDZ flat to up, SNDK flat (sold Nov $22s for $1.33 in a spread), JNJ flat to up and then, at 3:15, I sent out an Alert to Members for 6 earnings plays.  This is something we're trying to do every day, set up quick pre-earnings plays to make very nice one-day profits.  Of course it helps to get things right but that's where fundamentals DO come into play.  The trade ideas were:

  • STX has flown so I like the Jan $17.50s for .65, selling the Nov $16s for .60 (net .05).  My expectation is they disappoint but then hopefully recover on a Santa Clause run after earnings.
  • SONC June $10/12.50 bull call spread for net $1.20 (SONC is at $11).  Just a bullish bet. 
  • TUP is interesting as they are at ATH and probably worth it.  Apr $40/45 bull call spread is net $2.30.  3x of those and selling a Dec $45 for $2.30 gives you one for free!
  • APD likely to look like DD – will show good numbers but so what.  Dec $85/80 bear put spread is $2.20, might be a good chance to take out $80 putter on a spike up.
  • CAL is one I do like at net $13.80 so selling naked Dec $15 puts for $1.20.
  • MS Jan $31/32 bull call spread is at .40 is just fun.

We'll see how these go but they seem pretty much on track so far – 6 for 6 would be nice.  Ideally these are quick trades that pay a quick 20% or better and if we allocate, for example, $1,000 to each trade we can make $1,000 even if one play doesn't pan out and then we can turn that one into a longer spread that will pay off over time.  TUP fits our international theme of doing business outside the US while cutting dead weight and MS was obvious.  CAL we're happy to own long-term, SONC as well and STX and APD were both plays that come about based on our observations of their peers who have already reported. 

This is how we're playing earnings this quarter.  It's not so much about whether or not we like the company long-term, long-term investing is a very dangerous thing!  This is about getting the sentiment right and using our normal option strategies to take advantage of the imbalances caused by a combination of earnings volatility and a totally irrational market – it's a great combination from our side of the table! 

On the other side of the globe, Asia had a mild pullback this morning on no particular news – just following our lead yesterday.  "We have seen broad-based falls in line with Wall Street, but it's been fairly muted," said Marcus Droga, private client adviser with Macquarie Private Wealth. Mr. Droga said he expected subdued trade before a slew of major Chinese economic data on Thursday, including third-quarter gross domestic product and September figures for inflation, industrial production and fixed asset investments.

Moody's economy.com associate economist Alaistair Chan wrote in a report the data will likely show continued improvements in the key indicators. "The government is attempting to stem the rise in overcapacity, but this will be hampered by its inability to remove stimulus measures, given that the economy is so dependent on them," Mr. Chan added.

Europe is down about 0.75%, as of 9am, despite huge numbers from DB, who tripled last year's profits, making $2.1Bn for the quarter.  10% of the profits came from tax gains and that sent shares DOWN 3.5% despite the great numbers.  As I said above, we may be reaching the point of diminishing returns for earnings, where almost nothing is good enough other than grand slam home runs like AAPL and GOOG had. 

As usual, we'll be looking for a good DIA spread ahead of the Beige Book.  Unfortunately, it's a long way to options expiration so there are no "cheap" contracts to be had like we did last time, when we picked up a 150% winner.  We'll likely take advantage of morning weakness to establish a long position – after all, we're bullish now – or at least we're trying to be



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